Total mutual fund costs

One amazing rule of investments is called the ‘Golden Rule of Investing’. The Golden Rule says “he who has the Gold, makes the rules of investing”. If this post gets you nostalgic, you must have been born in the 1960s!

Once upon a time there used to be a ‘ring’ in The Stock Exchange (you dummy it had to be just called this, because the other ones did not exist). The Stock Exchange, Mumbai became the BSE – the Bombay Stock Exchange. The people with the ‘sauda’ book went into the ring and executed the transactions. Quotes were given by jobbers (called taravaniwalas). The daily turnover used to be around Rs. 200 crores – anything higher was considered great. There were 100,000 graduates / undergraduates who worked as jobbers, clerks going into the ring, sub-brokers, share transfer clerks, etc.

Then came technology – and the peopl who brought it said ‘now there is tranparency’ – after all the tech people, ‘educated’ people, etc. had to create new terminology. So out went badla, and in came F&O….and many such changes. Jobs changed hands. Frankly do not know whether the benefits went to the investor or the people who created a big army of financial service sector jobs. It would be intersting to see the ‘wealth created’, the ‘salary paid’ , the turnover tax paid…velocity benefits everybody except the investor (assuming he is still alive!).

Then came the mutual fund industry – ‘wealth management’ they said it was. Again distribution was required, professionals were required – so ‘charges’ were imposed. Some people made an attempt to understand the charges – the super big guys understood and negotiated it. The smaller guys do not understand the charges though there are some who pretend that they do. The amount of expenses that an amc can charge is decided by the amount of money that they can charge as expenses and its own fees. These were fixed when the aum of the biggest amc was under Rs. 1000 crores. Now it is Rs. 100,000 crores. Mr. C B Bhave has an advisory committee which is supposed to benefit the end investor. I have not seen any MD of any company of any industry say “Regulator please reduce my charges so that the end customer can benefit”. Well bureaucrats have some simple illussions in life, do they not.

For a customer who invests Rs. 100,000 a year for 30 years the load that he pays would be Rs. 2000 * 30 = Rs. 60,000. However even if the fund puts in a mediocre performance, the amc charges he pays would be Rs. 250,000 in THE THIRTIETH YEAR ALONE!

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5 Responses to “Total mutual fund costs”

  1. OK, once again, your last paragraph caught me…here goes:

    1. I presume you are making assumptions regarding growth over the 30 years of investments to arrive at the 2.5 lakhs figure for the 30th year. Without growth, 2.5 lakhs out of 30 lakhs would be close to 10%, and no amc charges that much as fund management fees.

    2. The question is what a customer gets for the fees they pay. The entry load that is passed back to the distributor gets the investor, in most cases, clerical services like filling out forms and conveying to the R&T office. On the other hand, a mutual fund houses, manages money from thousands of people, hence needs to pay the R&T, as well as the core act of fund management with professional money managers.

    3. Of course, the AMC would deserve it only if the fund is performing well over the long run. If a fund is turning in a “mediocre” performance, I hope the investor does not stick with it for 30 years!

    4. True, there is a case to be made against exorbitant fund management fees. However, these fees are transparent and, in a competitive arena, investors can choose between performance and non-performance and weigh it over the fees charged by the AMCs.

    5. In summary, when an investor buys a scheme, they can look at the performance and fees of different schemes and make their choice. When an investor chooses a distributor, they can look at the service and fees of different distributors and make their choice. Sounds fair to me. Till date, the situation was the distributors could not compete in terms of quality of service since they were all FORCED to get paid the same (via the entry load, which was not tied to the distributor, but to the scheme). Now this artificial leveler has been removed, and distributors can compete based on the services they offer and price themselves accordingly.

  2. Srikanth,

    have been in the banking industry for the past 20 years and watched mf industry. Competition has not reduced costs for the end customer. 42 fund houses – nobody has dropped charges. Some characters had done away with the distributor but amc charges even for them is sky high (max!!) – they pay no trail. Could write a chapter on hidden charges – the worst is brokerage (and churn costs). To say good and well performing funds will collect money is like saying ‘banks do not exist’. Instead of squeezing one part of the chain, sebi should have reduced the amc charges on equity funds from 2.5% to 2% max. High time they did that. Investors would have benefitted. Now the amc will part with the 0.5% to the distributor – after all not all investors are like you. For example I am too lazy to do the whole exercise of form filling, but my distributor rebates my whole commission (upfront for one year) even in an SIP because of the leads that I give him (i am now in HR and have no sales targets!!)

  3. Pooja,

    For every type of successful product, and products in the financial services industry are no exception, there is a point of inversion when it goes from a push product to a pull product. It is debatable whether MFs in India are at that point yet. When that happens, theories of open market competition will win out causing reasonable price/performance ratios.

    Having said that, I agree that rationalization of AMC charges should also be addressed by SEBI in the interests of the investors.

    And I know who you are referring to as “some characters”…we dealt with the same characters as well, and could not agree with you more…


  4. Had to join in on the debate! Fund managers need to be compensated well for sure. However the best performing fund houses tell you their ‘systems’ ensure results, not the people. So the compensation debate continues. The sales guys have to bring in the money. NOrmally the non monetary (cannot be given in cash) benefits are equal to the ‘commissions’ earned especially for the higher end guys. Have seen cheques in 8 digits for sales guys. Who pays for all this? For a first few years the shareholder, then the fund investor. How much a fund manager should be paid, how much the systems guy be paid, how much the sales guy be paid….the job market decides, not the customer. However I have seen customers with 8 and even 9 digit cheques squeezing EVERYTHING out of the fund house!!

  5. I liked Srikant’s comment saying
    ‘core’ function of fund management. Well said. Most of the fund houses outsource r & t, – how many of them have the guts to ‘outsource’ sales? afterall sales is not a core function. NOBODY. To have enough margins you need to control – sales, loads, amc charges. Why cannot 50 distributors gettogether and float an amc with only index funds? It is quite easy to get somebody to come as a sponsor….the distributors suddenly manage the fund with a ‘system’ which could cost a few crores, but do not need a fund manager.

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